Deflating Populism

For today's discussion, I offer Exhibit A:

This graph shows a line staying at a low level for most of American history and then suddenly shooting upward. Many people are worried about this line because it measures a quantity that is usually considered to be a Bad Thing: credit market debt as a percentage of GDP.

I offer two hypotheses to explain this graph. The first is a favorite of right-wing populists and libertarians, and was endorsed by Mencius Moldbug (the blog proprietor who was the immediate source of Exhibit A):

Hypothesis 1: Modern American wealth is illusory. It is built on a pyramid of debt and will eventually collapse. Our economic growth is driven by borrowing more and more money. This is not sustainable.

Those familiar with Ron Paul, Pat Buchanan, or other economic populists will immediately recognize hypothesis 1. It has a certain intuitive appeal and fits well within the narrative of modern social decay preferred by the paleocons.

The second hypothesis comes from a very different perspective. To me, merely stating the second hypothesis deflates the appeal of the first:

Hypothesis 2: The timing of the explosive growth of the credit market coincides with exponential growth in commercially available computing power. Technological change drastically reduced frictional transaction costs involved in complex capital transfers, creating a greater number of profitable credit transactions at the margin. The ventures funded by these marginal transactions have generated value over time and increased average human prosperity. A large credit market is a beneficial side-effect of a healthy modern economy.

You may want to call hypothesis 2 the "skeptical", "conservative", or "Panglossian" hypothesis, depending on your point of view.

Share this

New Economy

Is that your "New Economy" explanation?

Sure, you could call it

Sure, you could call it that. The economy is always changing.

A priori, I don't see any reason why the volume of credit transactions shouldn't increase as the marginal cost of producing them goes down. Historically, finance has relied on a lot of human labor, trust, and guess work. It has recently been removed from some of those restrictions.

Whether or not the volume of borrowing is higher than it "should" be is a different question. However, I just point out that it is reasonable that credit levels "should" be higher than in the past. There is nothing about that graph that makes me think that we are all doomed, a priori.

New New Economy

"Sure, you could call it that. The economy is always changing."

It was a reference to Alan Greenspans incorrect estimation of the internet bubble.

A priori, I don't see any reason why the volume of credit transactions shouldn't increase as the marginal cost of producing them goes down. Historically, finance has relied on a lot of human labor, trust, and guess work. It has recently been removed from some of those restrictions.

You are just rationalizing. The chart doesn't say much of anything without other data. Data we have. Why rely just on the chart? We know the effects of low interest rates, so we can tell if that is the major cause by looking for a whole series of effects. Lowered transaction costs do not explain all the other symptoms we've had for the past 20 years. Monetary expansion explains them all.

One of the effects of below market interest rates is excessive borrowing. However another is low savings rates. If this was only a matter of lowered transaction costs then savers would gain benefits too and you would expect savings to go up, not down. So your theory fails it's first test.

Furthermore, below market interest rates also cause asset bubbles, and trade deficits, commodity price increases, etc. Those symptoms all occurred while Greenspan was pumping out the money and he ignored them.
They were all signs that interest rates were too low.

Whether or not the volume of borrowing is higher than it "should" be is a different question.

One easily answered by the current situation. In case you didn't notice there are a heck of a lot of people who are not able to pay back what they borrow. So many that the U.S. government is looking at taking on 9.7 TRILLION in garbage debt!!! If that isn't an indicator of borrowing being a little to high I don't know what is. Furthermore, the government itself is up to it's eyeballs in debt.

"However, I just point out that it is reasonable that credit levels "should" be higher than in the past."

That's a rosy glasses interpretation. I certainly agree that lowered transaction costs should increase the number of savers and borrowers that can be paired profitably. But we are not seeing "pairing". So it's not a significant effect.

Furthermore, transaction costs are highest for small loans, but the collapse we are seeing is in the large loans. That's because most of the borrowing was done big and through home borrowing, not credit cards.

"There is nothing about that graph that makes me think that we are all doomed, a priori."

Those who's opinions differ from yours are not basing their understanding by looking at one graph "a priori".

We are in the middle of a currency (not credit) collapse. Doesn't mean we are doomed but we do have to pay the piper. Problem is that "we' didn't elect Ron Paul, but instead Obama. So instead of fixing the problem our president is going to make it worse.

Does that mean "we're" doomed? I certainly don't think the political powers that got us into this mess, Barney Frank, Greenspan, Raines, fat cat bankers, etc. are doomed. They have their millions socked away for a rainy day. Plus most of them don't even pay their taxes like Rangel, et al.

The rest of us are going to be screwed over by high taxes, plus high inflation, while our homes drop in price, and the government eats up real savings (and existing capital) to waste on government programs.

Sound like a recipe for success?

The optimistic

The optimistic interpretation would be more plausible if we didn't see a previous spike-and-crash in the debt in the early 1930s. That, along with the extensive evidence we already have that the mechanisms for monitoring debt quality became corrupted, provides us with good empirical reason to doubt the optimist case.
On the theoretical side, you have Steve Keen (see here) - who, I think, provides a much better diagnosis of the issues than the more-or-less Austrian critique that you associate with the pessimists.

I don't think the underlying

I don't think the underlying characteristics of the modern market are very similar to what they were in the 30s.

technology?

>A priori, I don't see any reason why the volume of credit transactions shouldn't increase as the marginal cost of producing them goes down.

Was the first spike caused by invention of the ticker tape? The availability of stock market information to the working class? If so, then were both crashes caused people confusing the availability of information with an increase of their own ability to process the information? As P. T. Barnum said, "Sucker born every minute."

Personal decisions or the result of government policies?

Some people borrow money. Other people lend money. The total amount of borrowing equals the total amount of lending. So why get upset when borrowing and lending increase? Isn't this just the result of decisions made by responsible adults?

No. Not when there are things like deposit insurance, government policies that led many financial institutions to believe that they were too big to be allowed to fail and government policies aiming to increase home ownership.